Navigating Mortgage Default Trends:
Insights from Fannie Mae Analysis
Ayush Mishra
Executive Summary
This report examines the loan default trends of Fannie Mae following the 2008 housing market crash, focusing on the significance of credit scores and loan purposes in predicting default probabilities. Analysis reveals that loans extended to applicants with credit scores below 700 contributed significantly to defaults prior to the crash, while cash-out refinances emerged as a notable correlate of defaults, suggesting potential financial strain. However, by 2019, these trends had largely corrected, indicating positive economic recovery post-crisis. The findings underscore the importance of credit assessment and loan purpose considerations in risk management for mortgage lenders.
Analysis & Observations
Fannie Mae has seen a significant drop in the default rate post the 2008 housing market crash with the current rate being lower than what was before 2007. As seen in the Figure 1 the loan default rate peaked during the crisis rising to the all time high of 9.13% and has slowly faded in the years to follow. From 2017 onward this change of default rate has been almost steady and better than ever before.
Figure 1: Default Rate Over Time
Credit score plays an important role in predicting the default probability of a loan applicant. We group our sample data using credit score of the primary loan applicant to analyse it correlation to defaulting on loan. In Figure 2 we can see that before the 2008 market crash a lot of loans were offered to applicant with credit score below 700 which directly led to high default.
Figure 2: Number Of Loans By Credit Groups
On comparing the default percentage by each credit group, in Figure 3 we can see that during 2007 many loan applicant that defaulted had a credit score below 700.
Figure 3: Percentage Of Defaulters By Credit Groups
The original unpaid principal balance, i.e., the dollar amount of the loan as stated on the note at the time the loan was originated was comparably equal for all the credit groups during the 2007, as seen in the Figure 4. However, this distribution seems to have been corrected by the year 2019 as shown in Figure 5.
Figure 4: Distribution Of Loan Amount By Credit Group: 2007
Figure 5: Distribution Of Loan Amount By Credit Group: 2019
Fannie Mae offers loans primarily to support homeownership by providing financing for purchasing homes or refinancing existing mortgages to promote access to affordable housing options and stimulate economic growth.
In our analysis, the purpose of loan was categorised into ‘Cash-Out Refinance’, ‘Purchase’ and ‘Refinance’. A cash-out refinance involves refinancing an existing mortgage for an amount greater than what is currently owed and a traditional refinance involves replacing an existing mortgage with a new one, typically to secure better loan terms.
The Figure 6 clearly shows that 52% of the loans that defaulted were taken to cash-out refinance. This suggests a potential correlation between defaulting on loans and the initial purpose of obtaining cash-out refinancing, which could be attributed to factors such as increased indebtedness or financial hardship.
Figure 6: Distribution Of Defaulters By Loan Purpose
Defaulting on a loan occurs when the borrower fails to meet the terms of the loan agreement, typically by missing payments or violating other contractual obligations. First-time defaulters have not previously experienced a default on any of their loans and may face consequences such as damage to their credit score, potential legal action by the lender, and difficulty obtaining credit in the future. During the 2007 market crisis almost 92% of the loans that defaulted were the first time defaulter which may mean that they took loan beyond their capacity or that the overall financial market was doing bad before the it crashed in 2008. This can be seen in Figure 7
Figure 7: Distribution Of First Time Defaulters
During the housing market crash, which reached its peak around 2008, several states in the United States were particularly hard-hit. Some of the most affected states included California, Florida, Nevada, and Arizona. These states experienced significant declines in housing prices, high rates of foreclosure, and economic downturns due to their reliance on real estate and construction industries. The effects of the housing market crash varied across the country, but these states were among the most severely impacted.
Figure 8 shows that these states had the highest defaulters for Fannie Mae while Figure 9 shows it current defaulters which is significantly low compared to 2007.
Figure 8: Defaulter Distribution By State In 2007
Figure 9: Defaulter Distribution By State In 2019
Conclusion
In conclusion, the analysis of Fannie Mae’s loan default rates post the 2008 housing market crash underscores the importance of credit scores and loan purposes in predicting default probabilities. Prior to the crash, loans extended to applicants with credit scores below 700 contributed significantly to defaults. However, by 2019, this trend had corrected. Furthermore, the purpose of loans, particularly cash-out refinances, showed a notable correlation with defaults, indicating potential financial strain. Despite the severity of the housing market crash, current default rates are considerably lower, reflecting positive economic recovery.
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